Markets are institutions that exist to facilitate exchange, that is, they exist in order to reduce the cost of carrying out exchange transactions. In an economic theory that assumes transaction costs are nonexistant, markets have no function to perform and it seems perfectly reasonable to develop the theory of exchange by an elaborate analysis of individuals exchanging nuts for apples on the edge of a forest or some similar fanciful example.

Many readers of Coase (including economists!) misunderstand him. This is evident in the improperly named Coase Theorem (it’s improper in that it’s not a theorem). In fact, Coase is so often misunderstood, he felt compelled to write the book this quote is from to clarify his point! Coase is often understood to say that, absent transaction costs (or sufficiently low transaction costs), externality issues (eg pollution, noise, etc) can be solved by an allocation of property rights and, regardless of their initial allocation, will result in a Pareto-efficient outcome. This is correct, but only a partial understanding of Coase.

Much of Coase’s work (and work that spun off from him, such as with Armin Alchian, Harold Demsetz, Gordon Tullock, and many others including my own) focus on the role of the market in addressing externality issues. Detractors from Coase argue that his insights, that markets for externalities can exist only if there are no/low transaction costs, are not applicable to the “real world,” since transaction costs abound and, therefore, government intervention is necessary. But this argument represents a misreading of Coase. In a purely ideal world, there would be no transaction costs, but then no market would be necessary. As Coase says in the above quote, it is in the world of transaction costs that the market is most useful! The existence of transaction costs gives rise to firms and other means of human collaboration, which in turn reduce transaction costs, and increase the market exchange of individuals (see The Nature of the Firm (1937) for a more in-depth conversation on this point).

Expanding the idea of markets, firms, and transaction costs to environmental issues, we see the rise of “enviropreneurs” (to use the phrasing of PERC), that is people who seek out and find ways to mitigate these transaction costs in order to achieve desired environmental ends; in short, a market process of environmental concerns (for a detailed look at many different kinds of enviropreneurs, see Free Market Environmentalism for the Next Generation, especially Chapter 9). The fact transaction costs exist is not a detriment to free market environmentalism, like the detractors of Coase argue, but rather what allows it to come about!

Like Coase (and Buchanan and many others) before me, I realize the market is not a panacea. There may be conditions for government to get involved (namely where involvement by the firm or an individual are too costly). But the work of Coase (and Alchian and Demsetz and Buchanan and Tullock and Anderson and many others) show us that the mere existence of an externality and transaction costs is not enough to justify intervention.

One basic query is: What is meant by rational behavior? Consider first what is not meant. Certainly not that people are necessarily selfish, “economic men” solely concerned with their own well-being. This would rule out charity and love for children, spouses, relatives, or anyone else, and a model of rational behavior could not be so grossly inconsistant with actual behavior and still be useful. A viable definition of rationality must not exclude charity and love; indeed, consistent family behavior probably requires love between family members.

Also, rationality should not imply that each household’s decisions are necessarily independent of those made by others. Different households are linked utltimately by a common cultural inheritance and background, and they may also be linked in a more proximate way. If household j increases its consumption of X, household i might be led to change its consumption of X. Such interdependicies commonly occur, and should be consistent with our model of rational behavior.

The essence of this model of rational behavior is contained in just two assumptions: each consumer has an ordered set of preferences, and he chooses the most preferred position avaliable to him.

…is from page 147 of the excellent new book Arguments for Liberty (edited by Aaron Ross Powell and Grant Babcock). This quote comes from the essay on Contractarianism by Jan Narveson (original emphasis):

Liberalism is exemplified by normative systems that hold two points: (a) that the sole acceptable purpose of rules, laws, and in general interventions must be the good of those intervened upon; and (b) that it is those persons themselves, rather than any supposed authorities, who fundamentally embrace those values. Individuals, then, are the basic holders of the values that interventionist institutions and personages are to respect….Both are essential. So-called liberals of the present day tend to think that they, the pundits or theorists or the elected politicians, know what people want better than the people themselves.

…is from Robert Tollison’s forward for the Liberty Fund edition of Jim Buchanan and Gordon Tullock’s classic work, The Calculus of Consent:

“Politics and the market are both imperfect institutions, with the least-cost set of institutions not being obvious in any real case. The moral: We must better understand how institutions work in the real world to make such choices intelligently.”

Hanson: Honestly, supply and demand. It is the part of economics with which more people have a passing familiarity, yet where even so a deeper fuller understanding would bring big gains. Someone who deeply understands just supply and demand understands a great deal.

For example, understanding all of the many ways in which the real world deviates from a supply and demand world can give one a deep understanding of the likely places to expect both market failures and useful innovations.

I confess that the wisdom and the beauty of these laws [of trade] evoke my admiration and respect. In them I see Saint-Simonianism: To each according to his capacity; to each capacity according to its production. In them I see communism, that is to say, the tendency of goods to become the common heritage of men; but a Saint-Simonianism, a communism, regulated by infinite foresight, and in no way abandoned to the frailty, the passions, and the tyranny of men.

JMM: I love this line because Bastiat is addressing two of his biggest critics in 1850’s France: the Saint-Simonianists (socialists) and the communists. Is Bastiat saying the goals of the socialists or the communists are ignoble? No. What he objects to are their methods (central planning, or leaving economic decisions “abandoned to the frailty, the passions, and the tyranny of men”).

Those of us who argue for freedom, of markets and of people, are often accused by our critics of not caring. Because we are not socialists, we do not care about the poor. Because we are not communists, we don’t care about the working man. Because we are not speech restrictions, we do not care about corruption in politics. Etc Etc. But nothing could be further from the truth! We care about these things; that’s why we argue for freedom. As Bastiat says, it is in these laws of trade and exchange (the economic laws) do we see the noble goals of communism and socialism accomplished without the ignoble aspects of frailty, passions, and tyranny that comes with socialism or communism.